The Best Way to Really ‘Fix’ Europe
06/21/2012 11:43 am EST
We often become so focused on the next bad news from Europe that we forget there are actually solutions, such as the one presented below, writes MoneyShow editor-at-large Howard R. Gold.
Forget Ben Bernanke and the Fed, forget jobs reports, forget the “fiscal cliff” that’s looming for the US late this year.
Right now, the markets are all about Europe—that Greek tragedy, Spanish drama and Italian opera rolled into one. Their hair-raising plots send markets up one day and down the next, although sometimes markets fall (such as right after the recent Spanish bank rescue and Greek elections) when you’d think they should rise.
But here’s the truth: Nobody—I repeat, nobody—knows what’s going to happen in the Eurozone. Not hedge-fund honchos or major Wall Street banks. Not German chancellor Angela Merkel or new French president FranÃ§ois Hollande. Not the media pundits who have been predicting the single currency’s imminent demise for the past three years.
And, quite honestly, not me. But I can make some educated guesses. And the way I see it, this “crisis” will probably last for years, as the 17-country Eurozone and the larger 27-nation European Union lurch toward a comprehensive solution, with some flareups of the kind we’re seeing now.
European leaders ultimately will be dragged kicking and screaming into making certain decisions that seem anathema now—more bailouts, a common euro bond, and tighter political integration.
But before we get to the end game, we need to clear a few hurdles. Greece may have to abandon the common currency; Spain and Italy will have to be bailed out, and Germany will have to step up big time, possibly modifying its sacred beliefs about inflation and strict austerity in the process.
First, Greece. Conservative New Democracy has formed a coalition government with “socialist” Pasok that has pledged to revise a €130 billion bailout deal Greece struck a few months ago with the International Monetary Fund and the EU. Publicly at least, German officials insist Greece must stick to the deal.
Easier said than done. Greece already has missed its deadline on finding additional budget cuts for 2013 and 2014. There’s even talk the EU and IMF will give Greece more time to meet its targets—which include selling assets and liberalizing the country’s sclerotic labor markets.
Trouble is, Greece’s economy is deteriorating quickly. The Greek government has stopped paying its bills. GDP this year may drop by 8%, unemployment now tops 20%, and there has been a stealth bank run. Not only are individuals pulling euros out of Greek banks and stuffing them under the mattress, but other European and international banks have dramatically reduced their Greek holdings.
“Austerity measures can result in a negative feedback loop,” Morgan Stanley wrote recently. “The more aggressive the government spending cuts and tax hikes, the more the economy is likely to shrink, which in turn could reduce tax revenues and lead to calls for further spending cuts and tax hikes.” Paul Krugman could have written that, and in this case he would be right.
Read Howard’s analysis of the problems with Krugman and Keynesianism.
The leftist coalition Syriza, which wants to renegotiate the bailout deal, got 27% of the vote in Sunday’s election, slightly below New Democracy’s total. It has vowed to fight the bailout in opposition. Together, far-left and far-right parties won more than 40% of the vote.
“Almost every day extremist violence breaks out in Athens and beyond,” Aristides Hatzis, a professor at the University of Athens, wrote in the Financial Times. “Greek people are disillusioned, miserable, exasperated and very frightened.”
That’s why I think the current government and bailout are too fragile politically and economically to last. I also don’t see how Greece will cut its debt from an unsustainable 160% of GDP to a slightly less unsustainable 120% by 2020—unless its economy suddenly gets way more competitive than it’s ever been.
If Greece were to leave the euro, Morgan Stanley estimates its new drachma would be devalued from 30% to 50%. It would almost certainly default on some of its debt. Estimates of the costs of a “Grexit” range from $250 billion for an amicable breakup to $1 trillion for a messy divorce.
But if Greece could be the Eurozone’s Lehman Brothers, Spain and Italy would be its AIG—so big, with so many interconnections, that their collapse would threaten the entire global financial system.
That’s why some European leaders may decide to write off Greece and concentrate on Spain and Italy. “We’ll let Greece go and save the rest,” said Matthias Matthijs, a professor at the School of Advanced International Studies at Johns Hopkins University.
Saving “the rest” will be terribly expensive. Together, Spain and Italy have €875.8 billion in bonds coming due by the end of 2014, according to Bloomberg. Two-thirds of those were issued by Italy, and both countries’ long-term interest rates are hovering around the 7% danger zone.
That’s why Matthijs says “the [European Central Bank] has to commit to buying all the Spanish and Italian bonds for the next couple of years.” That means they would have to pony up nearly €1 trillion for Spain and Italy alone.
Read about the the four things the US got right, but Europe didn’t at The Independent Agenda.
Spain is in trouble because it had the Mother of All Housing Bubbles, whose aftermath drove unemployment to 25% and blew massive holes in banks’ balance sheets and tax revenues. A €100 billion rescue package wasn’t enough to fill them. As for Italy, it’s simply the classic example of “too big to fail”—a stagnant economy with political paralysis and a debt to GDP ratio of 120%.
And who exactly is the “they” who might save the euro? Well, it’s really Germany, maybe the single currency’s biggest beneficiary.
The relatively weak euro has helped Germany become the world’s third-largest exporter, with a healthy trade surplus. How many fewer BMWs, Audis, and Siemens (SI) turbines would it have sold in Asia and the US—and throughout Europe—if Germany still had the deutsche mark instead of the euro?
Many are urging Germany to kick in more money to the emergency funding facility, support eurobonds, allow the ECB to be a “lender of last resort,” and stimulate consumption and allow a little more inflation in Germany itself.
But that’s like asking someone to eat shrimp who’s allergic to seafood. Saving and delayed gratification are embedded in the German character. The hyperinflation of the Weimar Republic in the 1920s is their biggest nightmare. And Germany instituted labor market reform in the last decade. Why can’t Greece and Italy do the same?
So, not surprisingly, the German public is opposed to issuing eurobonds and bailing out countries they view as profligate. Angela Merkel, who’s in a shaky coalition and faces elections next year, so far has strongly opposed both.
But in two recent articles in Foreign Affairs, Matthijs and co-author Mark Blyth urged Germany to step up and assume the leadership role it should naturally play in Europe. “The problem today is not German strength but German weakness,” they wrote.
“Germany can take a great leap forward,” Matthijs told me. “[Merkel] has a huge moment when she can mold public opinion in Germany.”
But that moment won’t last forever, he cautions. “We’re running out of time.”
Howard R. Gold is editor at large for MoneyShow.com and a columnist for MarketWatch. Follow him on Twitter @howardrgold and catch his coverage of next week’s Supreme Court decision on health care reform at www.independentagenda.com.